Bond market bazball...

More interest rates…

We remain in unfamiliar territory. Interest rates continue to rise sharply, and with them, the risks of something else breaking in the world economy. Many of the behaviours, contracts and investments struck in the (relatively) benign years running up to 2020 are under increasingly visible strain.

So far, the various leaks caused by all this pressure have been handled. Silicon Valley Bank and others vanished spectacularly, but so far not catastrophically from the perspective of the global economy. The resilience has been impressive in the face of this step change in borrowing costs.

The question still occupying many investors is whether this can conceivably continue? Surely something economically nasty lies ahead? Some of the lead indicators that have accurately (but never infallibly) warned of doom before remain discouraging (Figure 1).

However, as we have cautioned before, it is already different this time. There are still excess savings in many households in the developed world for a start. This slowly dwindling savings arsenal, allied to a still strong employment backdrop continues to supercharge the services side of the US economy on the evidence of this week. There is no comparison historically for either the scale of the service sector’s influence, nor the pandemic inflicted blows that it is bouncing back from.

A soft landing?

The public debate on this subject is often reductive – the world economy, and its constituents, either avoid recession or endure one. The sensible investors will ignore most of this. The impressive resilience so far cannot be easily extrapolated, particularly with interest rates at most maturities in many countries still rising.

There are still mitigants. That store of excess savings is running down admittedly, but still has some way to go. Happily, in the UK there is a lot of overlap between the households with excess savings and those facing the majority of the incoming mortgage burden.

We can also argue that the world hasn’t had the chance to build up too much of the kind of concealed economic extravagance that often precedes the very worst recessions. A few years of very little but crisis after decades of relative calm has seen to that.

Even so, we remain in a nervous moment as suggested above. Demand for workers remains too hot for comfort in much of the developed world, particularly the US on latest data. Unless this demand cools substantially, the central banks will feel that yet more interest rate rises will be needed.

Investment conclusion

There are, as usual, many potential paths ahead for the world economy in the months ahead. Handicapping the likelihood of those various strands of the future is especially challenging right now, as the major changes in market pricing this last year or so would suggest. The risks of something breaking are indeed rising with those interest rates.

However, the advantage we have as longer-term investors is that we don’t really need to pay much attention. All of these market gyrations amidst the ever-shifting probabilities are mostly irrelevant to our long-term returns. How much the technological frontier changes between now and when we decide to sell our diversified fund or portfolio will be much (much) more important.?

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*This article is for information purposes only. It is not intended as a product offer or investment advice